Taxation and e-commerce

Taxation and e-commerce

It's very difficult for the IRS to police the taxation laws for e-commerce

You can use electronic commerce (e-commerce) to sell, lease, or deliver a wide range of commodities. As an e-commerce supplier, the commodities in which you deal can include physical goods, such as books and CDs, and intangible goods, such as music sent as an e-mail attachment.

There are many facets to e-commerce that make it very difficult for the Internal Revenue Service (IRS) to police the taxation laws for this method of trading.

The difficulties of taxing e-commerce

The distinguishing trading features of e-commerce

The traditional method of commercial trading involves a customer and a supplier, both resident in known physical locations, a good or service, and money, all of which are tangible objects. A transaction takes place between the customer and the supplier, in which the supplier gives some good or service to the customer and the customer gives money to the supplier. If the customer and supplier are physically distant from each other, the goods will be sent to the customer by a registered carrier and payment can be made by check or credit card. Each aspect of this transaction is recorded on paper. The relevant paperwork then goes through the supplier's accounting system and the tax paid by the customer to the supplier is passed on, in due course, to the IRS.

The IRS has always had difficulty collecting taxes from such nebulous traders as traditional, out-of-state mail-order companies, but collecting taxes from e-commerce companies presents a much more serious and difficult challenge.

In contrast to the traditional method of trading, there are many factors that contribute to the difficulties experienced by the IRS in effectively taxing e-commerce transactions.

E-commerce leaves no paper trail

If no paper trail exists, the IRS cannot know that a transaction took place

In general, e-commerce transactions don't leave a paper trail. If no paper trail exists, the IRS cannot know that a transaction took place.

Suppose, for example, that you are an e-commerce computer games supplier who allows customers to buy games from you by downloading them from your web site. Although you are supplying to customers in the United States, your company might not be situated there. As well as that, your customer's Internet service provider (ISP) could be abroad. The difficulty that the IRS would experience in trying to trace your sales transactions is compounded by the fact that your customers pay for your games by entering their credit card details on your web site. Transactions of this kind are, from start to finish, recorded only intangibly—electronically.

E-commerce often has no carrier

The difficulties faced by the IRS in collecting income tax on e-commerce transactions are increased when there is no carrier for the goods in question, as happens when the object purchased can be sent electronically. Furthermore, in many cases tax laws to cover the sale of intangible goods do not exist and it is difficult to define these intangible objects, such as a downloadable file of music, and to formulate laws that will encompass their sale, in the IRS tax net.

E-commerce supplies taxable and non-taxable goods You will notice that many software packages are supplied with e-mail support. A customer who buys this kind of package is buying a taxable object, the software package, and a non-taxable one, the e-mail support. This complication adds further to the problems faced by the IRS in specifying tax legislation for e-commerce.

The IRS faces a dilemma in deciding which commodities are taxable and which are not. This problem stems from the fact that existing tax laws were in place before the invention of saleable objects of an intangible nature. For example, a dichotomy exists if a sales tax is imposed on the sale of a computer game on a CD-ROM bought in a computer store, whereas the same game, downloaded from a web site, is not a taxable item. In contrast to this, most newspapers are not taxable, so it would be punitive to tax them when they are being sold as a downloadable item.

Paying with e-cash

When a customer uses e-cash, no recordable movement of cash occurs

It is likely that electronic money (e-cash) will become a popular method of payment for purchases made through the medium of e-commerce. E-cash is a debit card that maintains a record of its cash balance by deducting the amount of each transaction. When a customer uses e-cash, no recordable movement of cash occurs, so this method of payment will further frustrate the efforts of the IRS to collect e-commerce taxes.

The current (to October 21, 2001) law on taxation of e-commerce

On October 21, 1998 Congress passed the Internet Taxation Freedom Act (ITFA), which imposed a three-year moratorium on both federal and state taxation of e-commerce. The logic behind this moratorium is to prevent individual states from imposing ad hoc e-commerce taxation laws before Congress has had time to research the issue in depth.

Congress decided that it would be wise to allow e-commerce to grow unhindered by the imposition of punitive, ad hoc taxation regimes. The complexity of e-commerce is such that, in the absence of proper guidelines, the likelihood of taxation being discriminatory is very real. For example, in cases where a transaction involves routing downloads through several states or countries, there could be an attempt to impose a tax on that transaction more than once.